In "Open Market Operations in a Model of Regulated, Insured Intermediaries" [JPE, forthcoming] we show that once-for-all open market purchases need not be inflationary. Here we show this result can carry over to various stationary accommodation rules given stochastic deficits. In particular, the inflationary and deflationary effects of stochastic deficits are not offset by, nor welfare improved by, a monetary policy that leans toward monetarism. Moreover, a constant money growth rule is not in the class of stationary policies given the kind of stochastic deficit we analyze, which by itself is a serious indictment of the monetarist proposal.

In this paper we analyze the constraints imposed by dynamic consistency in a model of optimal taxation. We assume that only distorting taxes are available to finance government consumption. Optimal fiscal policy requires the use of debt to smooth distortions over time. Dynamic consistency requires that governments at each point in time not have an incentive to default on the inherited debt. We consider policy functions which map the history of the economy including the actions of past governments into current decisions. A sustainable plan is a sequence of history-contingent policies which are optimal at each date given that future policies will be selected according to the plan. We show that if agents discount the future sufficiently little and if government consumption fluctuates then optimal sustainable plans yield policies and allocations which are identical to those under full commitment. We contrast our notion of dynamic consistency with other definitions.

In this paper we analyze the constraints imposed by dynamic consistency in a model of optimal taxation. We assume that only distorting taxes are available to finance government consumption. Optimal fiscal policy requires the use of debt to smooth distortions over time. Dynamic consistency requires that governments at each point in time not have an incentive to default on the inherited debt. We consider policy functions which map the history of the economy including the actions of past governments into current decisions. A sustainable plan is a sequence of history-contingent policies which are optimal at each date given that future policies will be selected according to the plan. We show that if agents discount the future sufficiently little and if government consumption fluctuates then optimal sustainable plans yield policies and allocations which are identical to those under full commitment. We contrast our notion of dynamic consistency with other definitions.

We investigate ex-ante efficient contracts in an environment in which implementation is costless. In this environment, standard debt contracts will typically not be optimal. Optimal contracts may involve defaults, even in states in which the borrower is fully able to repay. We then examine the welfare costs of arbitrarily restricting the set of feasible contracts to standard debt contracts. When model parameters are calibrated to realistic values, the welfare loss from exogenously imposing this restriction is extremely small. Thus, if the implementation costs are actually nontrivial (as seems likely), standard debt contracts will be (very close to) optimal.